Tax Breaks for Foreign Affiliates May End Under New Congressional Bill

A new bill designed to end tax breaks on premiums paid to affiliates domiciled outside the US is being introduced by Representative Richard Neal, D-Mass., which could impact the insurance sector and treasury operations.

The question of how premiums paid to foreign reinsurance affiliates have escaped tax in the past is a contentious issue in Congress. Rep. Neal, said last week that the legislation he is now introducing will close the long-standing tax loophole that allows US corporations to shift reserves into offshore affiliates to avoid paying taxes on investment income. Treasurers in the sector using this tax efficiency measure should be aware of the planned changes.

Neal’s bill would defer tax deductions for reinsurance premiums paid to a foreign affiliate. Foreign-based insurers would also have the ability to elect to be taxed similarly to a US company on the income associated with these transactions. The legislation allows for tax credits to offset any foreign taxes paid on such income to prevent double taxation. The proposed legislation would not affect third-party reinsurance transactions.

According to Neal several US companies have formed offshore reinsurance subsidiaries to avoid investment income tax requirements. Unless Congress takes action, Neal said capital migration will continue to grow, citing industry experts who say that forming offshore companies will become a “competitive necessity” for many US primary specialty insurers.

“As we grapple with significant budget challenges in the years to come, it is essential that we not allow the continued migration of capital overseas and erosion of our tax base,” Neal told congress last week.

Since 1996, the amount of reinsurance sent to offshore affiliates has grown from a total of $4 billion ceded in 1996 to $33 billion in 2011, including nearly $20 billion to Bermuda affiliates and over $7 billion to Swiss affiliates. Over the same period, the market share of direct premiums written by groups domiciled outside the U.S. has gone from 5.1% to 11.1%.

Neal’s bill is being supported in the Senate by Senator Robert Menendez, D-N.J. But the pair tried to introduce similar legislation last year, which failed to gain traction in Congress. At the time, economic consulting firm The Brattle Group released a study of the Neal-Menendez bill which found that ending the policy would reduce the net supply of reinsurance in the US by 20% and raise premiums by $11 billion to $13 billion.

President Obama, however, supports an end to the tax breaks, so a new push is underway. In his April 10 budget proposal, the president said ending the tax breaks would cut $6.2 billion from the federal deficit by 2023.

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